Risks Surfaced by the Anthropic-DoD Dispute

By: Margaret M. Cassidy & Andrew Swick

The Anthropic-Department of Defense (DoD) conflict raises compelling legal and policy issues, but these debates don’t help a business make payroll. [Click here for The Defense Salon article with detailed background on this conflict and here for an update on the court cases.]

For federal government contractors, businesses in the government supply chain, and companies looking to move into government contracting, constitutional and acquisition regulatory arguments matter—but less than the threat of losing value after being labeled a national security supply chain risk, well before they can even file a challenge in court.

The Anthropic-DoD dispute resets what doing business with the federal government looks like for now.  Contractors long understood that the federal government held immense power in the contractual relationship, but acquisition regulations and laws imposed limits and offered some stability.  Similarly, policy shifts between administrations were expected.  Policy changes based on unclear, inconsistent ideological requirements and deployed as reasons to terminate a contract are not.  If DoD’s methods for banning contracts are upheld in the courts, contractors and subcontractors throughout the supply chain need to prepare for the implications and plan for an even more asymmetrical contractual relationship.

These risks manifest in several areas:

• Innovation at Risk: Intellectual property rights may be jeopardized in an ecosystem that a business cannot control.
• Financial Instability: Revenue is now as vulnerable to shifting policies as it is to contract performance.
• Contracts & Acquisition Regulations May Not Hold Up: The executive branch can sledgehammer contractual terms and acquisition regulations.
• Reputation is the First Casualty: A government determination that a business is a supply chain risk can turn a business’ name into click-bait and send both customers and investors running.

1. 1. Innovation at Risk: IP Exposure and Liability for How Technology Is Used

Government integration requires exposing proprietary technology to agency scrutiny and the broader contracting ecosystem. Without establishing robust IP protections upfront, a company may lose control of its tech the moment a dispute arises. Worse, if the government deploys technology in ways it was not designed to be used for, it may be unsafe, or damage IT systems and other platforms resulting in downstream liability with almost no leverage to prevent it.

As Anthropic’s case shows, explicit contractual usage restrictions may be overridden, and publicly objecting to dangerous uses can itself trigger termination. Developing IP for the government and integrating with the government means exposing core IP to an ecosystem a business cannot control, with licensing and access boundaries becoming contested precisely when they matter most.

2. Financial Risk: Sudden Value Destruction

Anthropic’s experience demonstrated that DoD’s mercurial policy decisions, aggressive public positioning, and approach to contracting can present financial risk by rendering a company or its technology toxic overnight.  If this happens, a contractor faces two immediate financial threats: stranded investment in products built on suddenly disfavored technology, and value collapse as capital markets, insurers, and customers price in government hostility immediately. Investments in security controls such as FedRAMP certification or security clearances are costs that may no longer have a return on investment.  Businesses that have single-product dependency or who primarily sell to the government are particularly financially vulnerable because of lost revenue and because investors may look to exit or walk away from pending deals.  No one is waiting for a court decision.

Companies weighing whether to invest in security clearances, cleared facilities, government-specific development environments, and the other fixed costs of federal market entry must now price in the risk that the government can exit the relationship and suspend them from contracting —regardless of legal mandates.

3. Contracts & Acquisition Regulations May Not Hold Up

Federal government contracting has always carried known risks, but also known rules — termination for convenience, orderly wind-down, and due process before a contractor is suspended or debarred.  This framework is now largely dismantled.  When DoD announced that Anthropic was a supply chain risk, banning the company and banning contractors from even commercial work with Anthropic, DoD blew up its contract with Anthropic and the acquisition regulations that defined how the two parties should do business.  It may even have improperly deployed the supply chain risk statutes to ban Anthropic.  Even when DoD walked back the ban on any contractor doing commercial work with Anthropic, it was too late — skittish Anthropic business partners who work with the government were looking to terminate contracts with it.

Some of the contractual and regulatory guardrails that federal government contractors have traditionally relied on to mitigate the asymmetrical risk of doing business with the government collapsed:

• De Facto Debarment. Acquisition regulations allow the government to debar contractors from government contracting. The regulations also require that the contractor is notified of the possible suspension/debarment along with the facts and the law that merit suspension/debarment. These same regulations afford contractors the right to challenge the government’s conclusion.

The Anthropic situation demonstrates the government can sidestep these requirements with what amounts to a debarment.  This move impacts downstream subcontractors as primes and higher-tier subs exercise their right to terminate contracts with the debarred entity.  As a result, businesses lose access to the federal market.  The defense technology ecosystem that supports DoD will take a hit because needed technology may not be available, even if the banned business prevails in court.

• Flowdown Exposure. Primes must flow down acquisition regulations to subcontractors and those subcontractors must flow down the same to lower tier subs. Contracts between primes and subs usually allow for unilateral and immediate changes if there are terms the government changes. If the government bans a contractor, primes are going to execute on the requirement by forcing subs to comply with the ban or by walking away from subcontracts resulting in an unstable defense supply chain.
• Retroactive Compliance. If contractors are ordered to remove previously generated AI-assisted code, platforms, software, integrated APIs or other embedded tools from government systems, they may not be able to do so rapidly or even completely remove the tools in a way that is untethered from operational reality. In turn, this may taint existing deliverables or create liability for work already performed and accepted.
• Cost Recovery Uncertainty. If the government declares a contractor a threat and determines it will no longer do business with that contractor, it is unclear if the contractor will be able to recover the wind-down costs of what is essentially a termination as it would be if the government terminates for convenience. Government contractors going forward are left with the uncertainty of whether the wind-down costs are recoverable at all.

3. Reputation is the First Casualty

When the government labels a business a supply chain risk or any other equally damaging label, the reputational damage is immediate, contagious and hard to unwind.  Contractors are not alone in incurring this type of damage, the federal government itself takes a hit to its reputation as well.

The “supply chain risk” label is damaging since it conveys that a business and its technology pose a risk to the government if its technology is integrated into an IT infrastructure or if it has access to data; and the risks is serious enough that it implicates national security.

Supply chain risk is not the only dangerous label. If the government publicly disputes contract terms or raises safety concerns about a product or platform, a company can be portrayed in a damaging light and chill the transparency that protects negotiations and performance.

The reputational hit from a government designation turns a company into click-bait damaging its reputation and decreasing value faster than an injunction can be issued.

Even if a court vacates the designation, the reputational costs do not disappear. Investors, customers or business partners that walk away may not return, and lost deals rarely come back.

The government’s reputation and credibility as a reliable customer also suffers as it ignores acquisition regulations.  Companies already weighing whether to sell their innovation into the defense market will grow more reluctant when they see how the government treats its commercial partners.

This is particularly damaging at a time when the government, especially DoD, is looking to do business with non-traditional defense contractors and purchase commercial solutions.

Bottom Line

Federal government contracting is about policy, communications and legal requirements with the government holding the power advantage.  Acquisition regulations are designed to this imbalance to some degree.

The Anthropic situation demonstrated that if the government collapses these guardrails, it is no matter whether the government action is legal or not because the government can move faster than any legal challenge.  The impact has a cascading effect: government contracts, subcontracts and commercial contracts may be terminated, and investment, acquisition and financing deals may be delayed or cancelled. Even if an injunction stops the government’s actions, the damage is done.

This marks a possible existential threat particularly for early-stage and venture-backed companies as a business loses federal market access.

What To Do?

Entering the federal market has always required an enterprise-wide risk assessment of regulatory requirements.  Now, this assessment needs to include a risk analysis to evaluate a swift pivot by the government that is public and unpredictable toward a particular contractor.

Consider the following to manage these risks.

1. Map Your Federal Exposure at the Architecture Level. Know exactly where your technology touches defense systems, national security systems, covered IT, and CUI data flows and document a real-time internal map of all APIs, models, libraries, and code generation with federal exposure. Consider designing IP for surgical disengagement from the government, so full platform rewrites are not required. Develop and build exit paths and substitution strategies to protect innovation.
2. Model Prime-Down Risk. Going forward, compliance certifications may be expanded; termination clauses may be revised; and requirements to immediately remove technology from government systems may be in sub-prime contracts to account for these risks. Consider re-drafting contract terms and be sure to review contracts for new terms.  Remember, primes may operate defensively to mitigate these risks by excluding business partners as subs, especially businesses new to government contracting.
3. Build Financial Runway for Policy Shock. If federal engagement is material to growth plans, financial planning must assume sudden customer attrition, delayed closings, and forced re-engineering costs because of shifts in policy. Avoid single-point dependence on any one federal agency, prime or subcontractor.
4. Establish Board-Level Federal Risk Governance. Federal engagement is a governance decision, not just a sales decision because it impacts the entire organization. Assign formal board oversight when going into the federal market and develop protocols for when new opportunities in the federal market require board approval.  Stress test strategic plans against government action and assess the risktolerance for aligning with DoD’s mission and national security.  When crisis hits, boards will be called upon to explain not only their response but their assessment for taking the risk.
5. Disciplined Communications. Public disagreement with the government may result in a communications war requiring a solid public advocacy plan, a plan to engage Congress, and board-level review of communications. The communication methods for disagreeing can be as consequential as what the disagreement is about.
6. Protect IP. Establish clear ownership boundaries, usage limitations, and liability frameworks before government integration begins. A company whose technology is deployed in harmful applications cannot assume contractual objections alone will provide protection. IP protection and liability planning are core business strategy — not legal formalities to address after a dangerous use forces the issue.
7. Pricing Deals. Volatile government policy should be priced into diligence and term sheets along with the same type of assessments for compliance with acquisition regulations. Federal contracting is not just a compliance issue; it is an enterprise risk that may directly impact valuation, fundability, exit paths, and survival. Consider engineering deals to withstand these risks through deal terms, insurance and due diligence.